Break-even analysis is the study of the amount of sales or units sold that are required to break even after incorporating all fixed and 澳洲幸运5官方开奖结果体彩网:variable costs of running the operations of a business. 澳洲幸运5官方开奖结果体彩网:Break-even analysis is critical in business planning and corporate finance because assumpti♛ons about costs and potential sales de❀termine if a company or project is on track to profitability.

Understanding Break-Even Analysis

Companies use break-even analysis to determine what price they must charge to generate enough revenue to cover their costs. Break-even analysis often involves analyzing revenue and sales as a result. It's important to differentiate sales, revenue, and profit, however. Revenue is the total amount of money earned from sales of a product. Profit is the revenue that remains after all expenses and co🐈sts of running the business are subtracted from revenue.

Types of Costs

The two costs involved in break-even analysis are fixed and variable costs. Variable cos🌺ts change with the number of units sold. Fixed costs remain somewh﷽at constant regardless of the number of units sold.

A variable cost would include the inventory or🧜 raw materials that are involved in production. A fixed cost would include the rent for the production plant. Break-even analysis helps compan🧜ies determine how many units must be sold before they can cover their variable costs but also the portion of their fixed costs that are involved in producing that unit.

Pricing Strategies

Company owners can compare pricing strategies with break-even analysis and calculate how many units sold will lead t🉐o profitability.

They'll have to sell more units to help make up for the lower amount of revenue earned due to the lower price per unit if they cut the price of their product during a marketing campaign to generate new sales. They'll need a large jump in demand for their product to pay for the fixed costs that are necessary to keep the business operating if they cut the price substantially.

They might cover their variable costs but not their fixed costs if they cut the price by too much and the sales forecasts for an increase in demand are inaccurate. They may see less demand for their product and not be able to cover their total fixed costs if they don't cut their price at all or the price per unit isn't competitive with the market,

Contribution Margin

A key component of break-even analysis is understanding how much margin or profit is being earned from sales after subtracting the variable costs to produce the units. The selling price minus the variable costs is the contribution margin.

The contribution margin is $120 ($200 - $80) if a product sells for $200 per unit and the total variable costs are $80 per unit. The $120 is the income earned after deducting variable costs and it must be enough to cover the company's fixed costs.

Formula for Break-Even Analysis

The break-even point occurs when:

Total Fixed Costs + Total Variable Costs = Revenue

• Total Fixed Costs are usually known. They include things like rent, salaries, utilities, interest expense, 澳洲幸运5官方开奖结果体彩网:depreciation, and 澳洲幸运5官方开奖结果体彩网:amortization. 
• Total Variable Costs are tougher to identify but they're estimable and include direct material, billable labor, commissions, and fees.
• Revenue is the unit Price times the number of units sold

We can solve any piece of the puzzle algebraically with this information. Each part of the equation (total fixed costs, total variable costs, and total revenue) can be expressed as a "total" or as a per-unit measurement depending on what specific break-even measure we require. 

Special Considerations

澳洲幸运5官方开奖结果体彩网:Net operating profit after tax (NOPAT) is the metric that includes taxes. You incorporate the cost of all actual operati🌸ons by using NOPAT including the effect of taxes. The widely understood definition uses🗹 revenue, however, so that's what we'll use.

It's important to account for taxes when calculating break-even quantities because they're a real expense that a company incurs. Taxes don't vary directly with the revenues. They're usually calculated on taxable profits instead. This makes it difficult to factor in taxes using our simple formula.

A solution to this would be to use net operating profit after tax or NOPAT. You incorporate the cost of all actual operations with this method, including the effect of taxes. We'll use the first formula to calculate the break-even point, however.

Types of Break-Even Analysis

You can analyze the break-even point for a company in various ways. They include the total amount of revenue needed, the numbe♐r of units that must be sold, and the price per unit necessary to reach the break-even point.

Break-even Total Sales

Companies sometimes want to analyze the total revenue and sales necessary to cover the total costs involved in running them. This formula helps calculate the total 🌸sales but the measurement is in dollars, not units: 

• Break-even Sales = Total Fixed Costs / (Contribution Margin)
• Contribution Margin = 1 - (Variable Costs / Revenues) 

This can be either peꦦr unit or total or exp✃ressed as a percentage.

Break-even Units Sold

Determining the number of🦋 units that must be sold to achieve the break-even point is one of the most common methods of break-even analysis. You may have to translate total dollar values into per-unit values depending on the data you have.

• Break-Even Units = Total Fixed Costs / (Price per Unit - Variable Cost per Unit)

We divide the total fixed costs by the contribution margin for each unit sold to calculate the break-even analysis.

Let's say that the total fixed costs are $10,000. We already know that the product sells for $200 each and the total variable costs are $80 per unit resulting in a contribution margin of $120 ($200 - $80).

Plug in the numbers ($10,000 in fixed costs / $120 in contribution margin) using the break-even formula above. The break-even point for sales is 83.33 or 84 units that must be sold before the company covers its fixed costs. The company will have paid 💟for its fi📖xed costs and will record a profit per unit from that point on or 85 units and beyond.

Break-even Price

Here we're solving for the price given a known fixed and variable cost as well as an estimated number of units sold. We know the sales price and are essentially deriving the quantity sold to break even in the first two formulas but we must estimate both the number of units sold or total quantity sold in this case and relate that as a function of the sales price we solve for. 

• Variable Costs Percent per Unit = Total Variable Costs / (Total Variable + Total Fixed Costs)
• Total Fixed Costs Per Unit = Total Fixed Costs / Total Number of Units
• Break-Even Price = 1 / ((1 - Total Variable Costs Percent per Unit)*(Total Fixed Costs per Unit))

Break-Even Analysis in Excel

There are several ways to model break-even analysis in Excel. The two most useful are to create a break-even calculator or to use Goal Seek which is a built-in Excel tool. We'll demonstrate the calculator because it better conforms to financial modeling best practices stating that formulas should be broken out and auditable. 

We can tell Excel to calculate based ꦏon units by creating a scenario analysis.

Or based on price:

We can easily ♍build a sensitivity matrix to explore how these factors interact. We can see a range of break-even prices from $28 to $133 given various cost structures.

The Bottom Line

Break-even analysis provides a business with critical information. It𒊎 measures how many units or sales it must sell of a product or service if it’s going to meet all its variable and fixed expenses but not have a dime left over. This provides guidance as to what prices it must charge to earn a profit.